Company, workplace, occupational, defined benefit, defined contribution, final salary, money purchase – know your pensions!
I spoke about the new state pension a couple of weeks ago, which is dependent on how much National Insurance you’ve paid over your working life. Assuming you get the maximum, it will give you £155.65 per week / £674.48 per month / £8,093.80 per year in today’s money. (You might get a bit extra if you’ve already built this up through the current additional pension system, which will cease in April).
If you are saving elsewhere because you want more than this when you retire, then you may be paying into another type of pension. There are lots of changes taking place with pensions regulations over and above the changes with the state pension, but before looking at what these are I thought it would make sense to look at the main types of pension available.
There are two main ways of saving into a pension, either you can save into a scheme run by your employer, or you can save into a private pension.
Employer-sponsored schemes (also called occupational or workplace or company pensions) are those set up by your company. Your employer contributes to the scheme on your behalf, and you may have to pay a minimum contribution also. You can choose to pay extra into the scheme, above any compulsory minimum, and sometimes your employer will pay the same again if you do this, ‘matching’ your contribution. If you have the option to be part of one of these schemes, then why wouldn’t you? They’re putting money into it for you!
Workplace – defined benefit
There are two types of company schemes, a defined benefit and a defined contribution scheme.
A defined benefit scheme is one where the pension you get at retirement is not based on how much you’ve saved over the years, but is based instead on how many years you’ve been in the scheme, and your salary. This could be your final salary (a final salary scheme) or an average of your salary over your time in the scheme (a career average scheme). Final salary schemes were more common in the public sector, and the amount of pension was worked out as a fraction of your final pay. An example of a final salary scheme formula would be that you get 1/80th of your final pay for every year in the scheme. If you’re lucky enough to have a salary-related scheme, then you’re in the minority, as most of these schemes have now closed as they are so expensive for the employer to run.
Workplace – defined contribution
Most occupational schemes are now defined contribution schemes, also called money purchase schemes. The pension you get back from one of these schemes is based on how much you and your employer pay in, how the invested contributions grow, and the charges the scheme deducts. With these types of schemes it’s difficult to predict what you’ll get at retirement, you’ll have to look at your annual statements which will include forecasts based on assumptions about inflation and stock market performance.
If you’re employed and not currently in a workplace pension, then it’s likely you will be enrolled into one before April 2019 as part of a process called ‘auto-enrolment’. Employers are being obliged by the government to automatically enroll all eligible employers into a workplace scheme, and to contribute on behalf of their employees, in order to increase the level of saving we all make towards our retirement.
If you don’t have the option of saving into an occupational scheme, for example if you’re self-employed, then you could save into a private pension, often offered by an insurance company. You can pay into a private pension at the same time as paying into an occupational scheme if you wish. All private pensions are money purchase schemes, so the amount you get at retirement will be based on how large a pension fund you can save up over the years – as outlined above, this will be affected by the amount you save, the investment performance, and the charges deducted by the scheme. If you’re employed, you might find your employer currently offers you one of these private pensions, possibly a group personal pension, or a stakeholder pension, but the pension contract will still be between you and the pension provider so if you move jobs you can continue paying into the pension. It’s possible that the charges for these types of private pensions will be lower if your employer has negotiated a group discount, and it’s also possible that they may contribute into it on your behalf also, but essentially it’s the same as a private personal pension.
Check out your pension options
A common feature of all pensions, and one of the advantages they have had over other types of savings, is that they are a very tax-efficient way of saving. You get tax relief on your contributions, the fund itself grows tax-free, and you can take part of your fund as a tax-free lump sum at retirement. There is expectation that the government will announce changes to the rules around tax relief on pension contributions in the next budget, and there are other changes with pension regulations that alter when you can take your money and what you can do with it. I’ll look into these in the coming weeks, but I guess the message for now is that if you don’t have a pension, at least look into what pension options are available to you. If you do have a pension, then know what type you have and what it is likely to provide for you. If this has piqued your interest and you want to read more about the different types of pensions, then you could do worse than check out The Pensions Advisory Service website.